Firstmac stronghold crumbles - removing actuals

So the cash flow positive strategy and high emphasis on strong yields has just become a more attractive an feasible as a way to proceed then?

 

Previously, where lenders took "actuals" , and using an example of $1 Million of debt at 4.5% Interest Only , they'd have assessed the $1Million of debt as costing you $45K per annum ie 4.5% x $1Million. Lenders are now pretty much all assessing your debt ( no matter what rate you are actually paying) at between 7% and 7.5%, so the same $1Million is now assessed as costing you 70-75K per annum.

This means that for every $1million in I/O debt, lenders (for servicing purposes) now consider you to be spending @ 25-30K more per annum than they did pre APRA. This is why borrowing capacity for investors with large amounts of debt has been so dramatically affected.

For principle and Interest debt at 4.5% , 250K of P&I will now be assessed as costing you $1663 per month ( based on 7% assessment rate) where it would previously have been assessed at $1267 per month. That equates to $396 per month extra , or $4752 per year . At 7.5% 250K of P &I debt will now be assessed as costing you 1748 per month instead of $1267 per month. That's $481 per month extra , or $5772 per year. Double those gaps for 500K of P&I debt. Double them again or $1 Million of P&I debt.

If we accept that many investors carry some non deductible P&I debt as well as I/O debt, you can see that the post APRA assessment rates will result in many investors hitting a capacity wall far sooner. This is why aggressive debt reduction will now be the most effective way to improve borrowing capacity over time, for the majority.

I say the majority because there will always be the lucky few who either already enjoy incomes where even in a post APRA environment their capacity remains generous, or who secure quite large increases to income from salary or rent which will allow them to replenish their pre APRA borrowing capacity - but let's face it, only a small percentage of the population probably fit the extreme income mould, and for the rest of us mere mortals, it's improbable that we will easily or quickly make up 25 -30K of income per $1million of debt just from rental increases. That will take years! Perhaps a decade if you have the entire $1million sitting against just 1 or 2 properties. So it will really need to be salary increases that will have to replace the majority of the 25-30K per $1million - unless you have some other windfall such as an inheritance or a lottery win and can pay down large amounts of debt that way. Again, that could take many years. For someone earning 70,80,90K, that's a 30-40% increase income. And if rates rise during that time , assessment rates will rise...so it may take much longer than just a few years.

Add to that the higher funding costs the banks will incur in 2018 as BASEL commitments commence worldwide and our lenders are required to migrate from short term funding to medium and long term funding arrangements - which will undoubtedly be paid for by investors not owner occupiers, via further increases to I/O money to subsidise P&I PPOR money , and then consider how many investors will reach the end of their current I/O periods in the next 5 years and will not be able to secure additional I/O periods - and there goes some more capacity, because those investors wont see any favourable treatment for their rates even if they revert to P&I. All the super cheap rates will be reserved for P&I PPOR business and subsidised by investors - just like is happening right now. So you can see how constrained borrowing capacity looks likely to be for many years yet.

The really good news is, P&I debt used for PPOR purchases are at their lowest ever and may well get lower - so it's feasible to commence a really aggressive debt reduction strategy and see really material results within just a few years. It's likely rates for P&I debt will remain quite low for some time, so this is the decade to have a really good go at paying off the PPOR mortgage

These forums have many clever souls who made a lot of money during the expansionary credit environment, and some may even be in one of the ultra high categories above and be lucky enough to avoid the APRA constraints ... but the bottom line for the vast majority remains - we are now entering a more restrictive credit environment and it's not temporary. Capacity has been substantially curtailed and in just 3 -4 months you've already seen it bite. With funding cost increases almost assured in 2018 and with I/O renewals being no certainty as lenders force more investors into P&I, that's all going to mean that a serious rethink about how to make money may be required.

My personal view remains that growth will slow quite a bit and these capacity constraints will stay for some time, so for the majority, accelerated debt reduction is going to be the single most effective way to compensate for that as it will create both the equity AND the capacity to continue to invest.

 

Okay, so this has me thinking.

In this environment buying a shiny new PPOR might hit serviceability hard and really restrict my ability to move forward with IP purchases.

Buying at higher yields, such as 6%, and concentrating more on cash flow will be important moving forward to push back that serviceability wall as far as possible.

And pay down debt

 

Mathematically that's correct - cash flow and debt reduction will really need to be rethought and reprioritised in this post APRA world. But it's not always that simple... I mean, what "value" do you place on a shiny new PPOR? What if you need an extra bedroom or two, or of it's a case of happy wife happy life - hard to ignore those things.

 

Yes that's right. But for us at the moment it is more of a want not need. We're probably 5+ years away from needing to upgrade our PPOR.

 

Well then yes, focusing on debt reduction for the next few years would seem the right thing in your situation, if you dont "need" to upgrade.

This very situation/environment (post APRA) - where capacity is much more limited and debt reduction becomes far more important - is precisely what has always underpinned my strong support for NRAS. It is precisely why I left my role at Firstmac and commenced this business . I knew then that there was absolutely zero doubt it was only a matter of time before the era of credit expansion ended, and a total rethink on building property portfolio's would be required, because the key ingredient required for manufacturing growth/equity would be severely restricted - credit.

Each NRAS property typically produces @ 8-10K CF+ , so with just 1 or 2 or 3 in a portfolio, significant debt reduction can be achieved in just a few years. This has the double benefit of creating equity (even in a flat growth environment) and also creating borrowing capacity. The trick is - you have to patient. It will take a few years to reap the rewards. As others have posted - borrowing capacity may initially be reduced because of the 20% less rental income received...but it doesn't take long for that imbalance to be corrected, as the debt reduction takes effect. But you can have the best of both worlds - when utilised with the Adelaide Bank or FirstMac policies - where the NRAS credits can be used for servicing - borrowing capacity is immediately and significantly improved.

It's easy to see a picture forming. We already enjoy ultra low P&I rates, likely to get even lower as banks use them as a weapon to win P&I business - and likely to stay low for some time - already creating the ability to make significant accelerated repayments on that portion of debt. Add to that, the capacity to further compound those benefits by adding 8-10K of additional accelerated repayments... the potential for genuinely material non deductible debt reduction is huge. Just imagine how much further investors can go if they have all or most of their non deductible debt paid off.

 

One more thing: Do the new serviceability calculations apply to non secured debt? Are credit card, and personal loan repayments now calculated at a higher rate or still at actual repayments?

 

Still at actuals. Or in the case of credit cards 2 to 3% of the limit.

 

There are a very small number of lenders who will ignore your credit card debt if you clear the card in full each month - but for the most part, most lenders will assess 3% of the limit as the minimum required repayment per month - which equates to 36% per annum. Doesn't matter whether you have used any of the limit or not. ie - the balance is not assessed - the credit limit is.

 

Thanks for taking the time to lay this all out Euro. Will be very helpful in considering my next move

 

Firstmac have also just announced that they will no longer be lending to Chinese non residents

"Firstmac is in the process of reviewing its Non Resident Borrower policy in line with ASIC investor lending guidelines and global market movement.

To decrease the risk of investors from China becoming over-represented in Firstmac’s lending portfolio, Firstmac will temporarily halt Non Resident transactions to these borrowers.

Pipeline applications that have reached preliminary approval will be honoured. However, they must settle within 90 days of final approval"